The Biotech Sector's Underperformance May Be About To Get Worse

The S&P Biotechnology Select Industry Index has fallen by around 1.5% in July, underperforming the broader S&P 500’s gain of over 1.5%. Drug prices have once again become a political topic as the U.S. 2020 Presidential Election comes into focus, weighing down hard on the sector.

The bad news is that the sector's underperformance may not only continue but get worse. Using the SPDR S&P Biotech ETF (NYSE:XBI) as a proxy for the Biotech Index, it shows that the ETF could see a significant drop based on a technical analysis by as much as 8% from its current price of $86.83.

SPX biosector

Technical Break Down

The chart shows that the ETF has been hovering around an important level of technical support at $85.25. However, the bad news is that all signs are suggesting the level of support may not hold. The ETF has already fallen below an uptrend which began at the end of May, which may now also act as resistance should the ETF rise. Additionally, it would appear a descending triangle may be forming, a bearish technical pattern. This would imply the stock may fall below the support level at $85.25, pushing the ETF to around $80, its next level of technical support.

The relative strength index is also beginning to trend lower since peaking near overbought levels at 70 in the beginning of March, suggesting that bullish momentum is leaving the ETF.

XBI chart

Drug Prices

One reason the sector has struggled in July is the debate around reducing the cost of drug prices in the U.S. Recently, President Donald Trump proposed a plan that would have limited the rebates a drug company could pay to benefit managers under Medicare. However, despite that plan being canceled, the sector has still struggled, because investors are nervously waiting for what may be the next attempt to bring down those drug prices.

The Presidential Election May Weigh

The negative focus on high drug prices killed the sector during the 2016 presidential election. From the end of July in 2015 until the election in 2016, the S&P Biotechnology Select Industry Index fell by over 32%. That is compared to an increased by about 2% on the S&P 500. Anxiety about threats to rein in drug prices, and the uncertainty of how that would happen, caused investors to flee the sector.

SPX biotech

Once the election was over and the talk died down, the index went on to rise by 65% from Nov. 8 through July 31, 2018. That was more than double the pace of the S&P 500's increase of 31.6% over the same time.

The Start Of Something Steeper

It may be too early to tell if a Biotech sector pullback is the start of something bigger and longer-term. However, it seems very clear it's on the mind of investors: the sector's underperformance didn’t just start in July. The group has been struggling since the beginning of April, having fallen by nearly 5%, versus the S&P 500's gain of over 4.5%.

Should drug pricing become a centerpiece of the presidential election in 2020, the recent underperformance could turn into something much more severe. Potentially as damaging as the one seen four years ago.

At this point, it isn’t even clear how much politics will play into the performance of the biotechnology sector. However, at the very least we can conclude that the four months of underperformance suggests investors are definitely getting very jittery.